By Vicki M. Daughdrill
Small Business Resources LLC
In previous articles, I discussed the hiring process itself. When deciding whether to hire an employee, it is essential to always consider whether you require an employee or can outsource the job to an independent contractor. Many small businesses rely on contractors. There are significant benefits to using independent contractors, including savings in labor costs, reduced liability, and flexibility in hiring and firing.
The IRS offers guidelines on whether workers can be classified as independent contractors or employees. This determination has significant tax consequences. An incorrect decision on the part of a business can result in great expense, plus considerable penalties and interest.
Expenses include reimbursement for wages you should've paid under the Fair Labor Standards Act, including overtime and minimum wage payments; back taxes and penalties for federal and state income taxes; Social Security, Medicare and unemployment contributions; payment of misclassified injured employees workers' compensation benefits; and provision of employee benefits, including health insurance and retirement account contributions.
When you hire employees, you have an obligation to withhold and pay federal income tax, Social Security and Medicare taxes, and federal unemployment insurance premiums in addition to any state or local taxes. You must also report wages to the proper reporting agencies and issue statements to each employee. In order to attract and retain outstanding employees, you may also need to provide a competitive benefits package to all employees. For independent contractors, generally no withholding is required, and the independent contractor is liable for all of the taxes described above.
What distinguishes an independent contractor from an employee? In general, an employee performs duties defined and structured by others, is trained on methods for completing the work, and works for only one employer. An independent contractor operates under a business name, has his or her own employees, maintains a separate business checking account, advertises his or her business' services, invoices for work completed, has more than one client, has his or her own tools, sets his or her own hours, and keeps business records.
The courts have established three main categories when determining whether someone is an independent contractor or an employee. These categories are fully described in Publication 15-A and on the "Independent Contractor or Employee?" page on the IRS website. The categories are:
In addition, the IRS has provided 20 questions to help workers determine whether they are employees. The answers will reveal whether they can be classified as independent contractors or as employees.
For more information, visit www.irs.gov/pub/irs-pdf/p1779.pdf Independent Contractor or employee?
Bill Gates said, "Virtually every company will be going out and empowering their workers with a certain set of tools, and the big difference in how much value is received from that will be how much the company steps back and really thinks through their business processes." As you work to develop, grow and expand your business, step back and review your needs. Then determine whether you should hire an employee or an independent contractor.
Vicki M. Daughdrill is the Managing Member of Small Business Resources LLC, a management consulting company. E-mail her at email@example.com or call her at 601-310-3594.
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